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The Mortgage Pre-Approval Process: How Credit Scores Affect Your Mortgage

Posted by Andy Brikho on May 31, 2018
Andy Brikho
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Your credit score is an important little number that has a huge impact on your financial life and the mortgage approval process. If you're planning to buy a home any time soon and need to take out a mortgage to finance it, your credit score will come into play. A good score can make it much easier to get final approval for a mortgage with convenient terms, while a poor score can make it almost impossible to secure a pre-approved mortgage loan at all.

 Credit scores are weighed heavily in the mortgage pre-approval process and can be just as important as your income and the value of the property involved in the mortgage. As such, it's essential that you ensure that your credit score is up to par. If it isn't, steps should be taken to make the necessary improvements of your financial situation. 

What is Considered a Good Credit Score to Secure a Loan Approval?

A large proportion of credit scores make use of the FICO model, which is based on a scoring range between 300 to 850. The higher the score, the lower the risk to the lender in a mortgage. On the other hand, lower scores represent a higher risk to the mortgage lender. 

Generally speaking, a FICO credit score of 750 or higher is considered "excellent." A credit score between 700 to 749 is considered "good," while a score of 650 to 699 is considered "fair." A poor credit score is anything under 650, making mortgage approval with attractive terms less likely. 

What Influences Credit Scores?

Many things influence credit scores, but perhaps the more influential factor is payment history. Buyers who are diligent about making their debt payments on time every month will be more likely to have a higher credit score. Conversely, buyers with missed payments on record will experience a lower credit score. 

Other factors that influence a credit score include the following:

Public Records

If you have had any bankruptcies, judgments or collections in the past, they will be noted on your credit report and negatively affect your score.

Length of Credit History

The longer your credit history, the better. A lengthy credit history will give lenders a better idea of what type of borrower you have been in the past.  

New Accounts

It is not recommended to open too many accounts in a short period of time, as this can have a negative impact on your credit score. 

Inquiries

Any time someone pulls your credit report - such as a lender, landlord, or insurance provider - your credit report will be noted appropriately. Such inquiries may have a negative effect on your score if too many of them are conducted over the recent past.

Open Accounts

Too many open accounts can negatively impact your credit score, regardless of whether the accounts are being used or not. 

How Do Credit Scores Impact Your Mortgage?

The information included in your credit report tells a lender what type of borrower you will be. A lower credit score indicates that you may be more of a risk because the chances of missed mortgage payments are much higher. In this case, lenders might not be willing to approve a mortgage.  

The opposite is also true: a higher credit score indicates that you may be a more responsible borrower and less of a risk because the odds of prompt and timely payments are higher. In this case, lenders are more apt to approve you because of your higher credit score.

While it’s up to the lender to decide what credit score a borrower requires in order to be approved for a mortgage, even a few points can mean the difference between mortgage approval or rejection. 

Not only does your credit score affect your chances of mortgage approval, it will also affect the interest rate that your lender offers you. While different lenders will have their own unique requirements, the general consensus is that borrowers with higher scores typically secure lower interest rates than borrowers with lower scores.

The interest rate on your mortgage is an incredibly important factor to consider, as it can make your mortgage more or less affordable. Obviously, a higher rate would mean you'd be paying more towards interest over the life of the loan, which would make the mortgage much more expensive compared to a loan with a lower rate. Just a few points on your credit score can impact the number of your monthly mortgage payments, mortgage rates and your debt-to-income ratio.

To illustrate, let's say you are a first-time home buyer and want to take out a mortgage of $400,000. With a sub-par credit score of 620, your lender hesitantly approves you for a mortgage, but at a high-interest rate of six percent. Based on a 30-year fixed-rate mortgage, your monthly mortgage payments would be $2,379.29.  

On the other hand, a credit score of 750 would place you in the "excellent" score category and would afford you with a lower interest rate. If the interest rate offered is four percent, based on the same numbers above, your monthly mortgage payments would be $1,902.07. That's a price range difference of $477.22 every month.  

Clearly, a lower interest rate has a huge impact on your monthly mortgage payments. If you can keep your score as high as you can, you'll have much better odds of getting approved for a lower rate which can make your mortgage much less expensive overall.

How Can You Improve Your Credit Score?

If time is on your side before buying a home and your credit score could use a little improvement, there are certain steps you can take to give it a boost:

Make Payments on Time

First and foremost, never miss a payment. As noted earlier, your payment history plays a key role in your credit score, so ensuring that all payments are made by their due date is crucial. Be sure to keep track of all income documentation including bank statements and pay stubs.

Keep Your Credit Card Balances Low

Keeping your balances less than 30% of your credit limit can help you give your credit score a boost. Never spend up to your credit limit, as this can have the opposite effect.

Pay Down Your Debt

The more debt you have on the books, the worse your credit score will be. Make an effort to pay down your debt as much as possible to help your credit score improve.

Leave Old Credit Open

Even if your old credit cards and accounts are not being used, leave them open. Leave old debt and good accounts open as long as you can as a means to improve your credit score.

Don't Take Out Any New Loans or Open New Accounts

The more loans and credit accounts you apply for in a short window of time, the worse off your credit score will be. Instead, focus on paying down your current debt and resist the urge to add new debt to the pile.

 Final Thoughts 

When it comes to your mortgage, your credit score matters. Basically, a higher score will increase your chances of mortgage pre-qualification and getting approved for a mortgage and will afford you with a lower interest rate. Not only will you be able to make your dreams of homeownership a reality, you'll also minimize your mortgage payments. Be sure to pull your credit report to see what your credit score currently sits at. If it could use some improvement, take steps to increase your score today to help with loan pre-approval.

Topics: Mortgage Process, Mortgage Rates, Credit Score, Mortgage Pre-Approval